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Analysis: Liberal Analysts Drop $42 Billion Bombshell Into NJ Pension Debate

Think tanks cite Pennsylvania actuarial study in warning against hidden costs of switch from traditional pension to 401(k) plan

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While Republican Gov. Chris Christie says New Jersey needs “to stop the insanity of a defined-benefit pension system that we cannot afford,” liberal policy analysts argue that New Jersey cannot afford the hidden costs of switching to a 401K-style pension plan either.

Launching a preemptive strike while Christie’s pension commission is still reviewing options, New Jersey Policy Perspective teamed with Pennsylvania’s Keystone Research Center to issue their own pension policy paper yesterday. The two think tanks concluded that shifting new employees out of the current defined-benefit pension plan would increase New Jersey’s future pension costs by some $42 billion and result in smaller retirement checks for those switched into defined-contribution plans.

“Most states that have considered switching employees to 401(k)-type accounts have rejected doing so because it risks putting a severe burden on taxpayers,” said Stephen Herzenberg, Keystone’s executive director. He noted that only Michigan, Alaska, and West Virginia have made the switch -- and that West Virginia changed back.

Herzenberg said actuaries for Pennsylvania’s two largest pension systems estimated that pulling new employees -- and their pension contributions -- out of the state’s defined-benefit plan would add $42 billion over 30 years to the cost of pensions for retirees and workers already in the current plan. “When Pennsylvania’s legislature got that eye-popping estimate in May and June of last year, that led Pennsylvania to back away from a switch to a defined-contribution account,” he said.

While New Jersey pension actuaries have not conducted a similar study, Herzenberg and Gordon MacInnes, NJPP’s president, said the $42 billion projection for Pennsylvania is a good back-of-the-envelope estimate for New Jersey because the two state pension systems have approximately the same total assets, unfunded liabilities, funding ratios, benefit levels, and number of retirees.

“The real pension problem in New Jersey is not pension-plan design, but the state’s failure across numerous gubernatorial administrations to make the required contributions,” Herzenberg said. “A lot of states have not made contributions, but New Jersey ranks 50th for share of contributions made compared to the amount that should have been made since 2003” -- a period that spans seven fiscal years under Democratic governors and five budgets under Christie.

MacInnes specifically cited Christie’s decision to cut $2.4 billion in pension contributions in the wake of last April’s plunge in income tax revenues, breaking his 2011 promise to ramp up to full actuarially required funding of the state’s massively underfunded pension system by 2018.

“What we need is for the state to make good on its funding promises,” MacInnes said. “What we don’t need is to move state employees into a risky new system that will make our funding problems worse and their retirements more insecure.”

MacInnes’ assertion that New Jersey’s pension crisis can be solved by requiring the state to come up with the money needed in the budget to get back on schedule to pay off the state’s $37 billion unfunded pension liability -- which would require the state to increase pension funding from the current $681 million to a least $4.8 billion a year by 2018 -- echoes the arguments of the public employee unions and Democratic leaders like Senate President Stephen Sweeney (D-Gloucester).

Sweeney, who put his political career on the line by teaming with Christie to pass a 2011 law that eliminated cost-of-living increases for retirees and increased pension and health benefit payments for current workers, is furious that Christie went back on their joint promise to adequately fund the pension system. He is adamant that the Legislature’s Democratic majority will not ask public employee union members to pay more when the state is paying less than its share.

Sweeney, as Senate president, has the unilateral power to refuse to post any proposed pension legislation he disagrees with. And he would like to win back the support -- or at least the diminish the opposition -- of the public employee unions for his own quest to succeed Christie as governor when the Republican governor resigns to run for the 2016 GOP presidential nomination or finishes his term in January 2018.

It is against that political backdrop that MacInnes and Herzenberg held a conference call with reporters yesterday to release Herzenberg’s policy paper, “How to Dig an Even Deeper Pension Hole: Ending Defined Benefit Plans Could Saddle New Jersey Taxpayers with $42 Billion in Transition Costs.”

It is a collaboration that carries political overtones on both sides of the Delaware River.

While MacInnes, a former Democratic state senator, has been one of the most persistent critics of Christie’s efforts to cut public employee pension costs, Herzenberg and his Keystone Research Center have led the charge against Republican Gov. Tom Corbett’s push to shift new Pennsylvania public employees from a defined-benefit plan to a defined-contribution system.

While Corbett, unlike Christie, has a Republican-controlled Legislature, the rock-solid opposition of Pennsylvania’s Democratic minority and the public employee unions, coupled with the inability of Republicans to agree on a single approach to pension reform, have stalled Corbett’s efforts.

Further complicating Corbett’s campaign for a pension overhaul is the Republican governor’s perceived political weakness: He is trailing Democratic businessman Tom Wolf badly in the polls and is considered the most vulnerable incumbent Republican governor in the nation, despite Christie’s fundraising and campaigning on his behalf in his role as chairman of the Republican Governors Association.

Consequently, to the relief of the public employee unions, both the Republican and Democratic legislative caucuses seem willing to put pension reform aside until after the election -- when Wolf presumably will be sworn into office.

Ironically, the legislative pension proposal that is attracting editorial notice in Pennsylvania is a plan by Rep. Mike Tobash, a Republican in the Pennsylvania House, to create a hybrid pension plan that would keep public employees in a traditional defined-benefit pension plan up to a certain salary level, then have the state contribute to a 401(k)-style plan on earnings above that amount.

Tobash’s hybrid plan is a refinement of the Rhode Island hybrid pension plan put together by state’s elected treasurer, Democrat Gina Raimondo, who is expected to be elected governor next month.

Under the Rhode Island plan, state employees with less than 20 years of service who paid 8.5 percent toward their traditional defined-benefit pensions now pay 3.5 percent toward their regular pensions, but put the other 5 percent into a 401(k)-style defined contribution plan with a choice of mutual funds.

Christie’s treasurer, Andrew Sidamon-Eristoff, last spring acknowledged that a “hard cutover” from a defined-benefit plan to a defined-contribution approach for current employees would add to the state’s unfunded pension liability, which was one of the reasons he said he found Rhode Island’s hybrid approach to be “an interesting model that bears analysis.” Undoubtedly, Sidamon-Eristoff and his staff shared their analysis of Rhode Island’s plan with Christie’s pension study commission.

MacInnes and Herzenberg said they did not study the transition costs of a switch to a hybrid plan, which would be difficult to do without having a concrete proposal to study.

“You can’t reach a judgment about the sense of a proposal without having the kind of detailed studies that these other states have gone through in considering a switch to a defined contribution,” MacInnes said. “You would have to do the same thing, frankly, if it is going to be a hybrid plan.”

Herzenberg, however, noted that “to the extent that people get retirement savings partly in 401(k) plans moving forward (under the Rhode Island hybrid plan), you would have the same problems with lower returns and higher costs.”

Herzenberg said studies showed that 401(k)-style plans return about 1 percent a year less than large state-managed pension plans, such as New Jersey’s, partly because employees managing their own investment plans make poorer investment choices and partly because they pay more in management fees. Over 30 years, the losses due to that 1 percent difference compounded year after year would require retirees to increase their contributions 45 percent or more to receive the same pension, he said.

“One of things that has not gone unnoticed,” he said, “is that one of the architects (of the Rhode Island plan) came out of the financial services industry,” he said, referring to Raimondo, a former Wall Street investment manager who, like Christie, has been criticized for her state’s increasing investment of pension money in hedge funds.

“Those higher fees increase revenues going to financial firms,” Herzenberg said. “To those of us who study the growth of economic inequality, it is hard to embrace the idea of a change in retirement plan design that will result in the flow of money from Main Street to Wall Street.”

Referring to the Pennsylvania actuarial studies of a shift to a defined-contribution system for new hires, Herzenberg said the $42 billion estimated additional cost over 30 years for the pensions of current employees and retirees left in the defined-benefit plan reflects two assumptions: (1) the lost employee contributions from new hires phased into defined-contribution plans and (2) the assumption that the Pennsylvania pension fund’s return on investment would drop because investments would have to be more conservative as more and more employees neared retirement age.

Assuming that New Jersey’s experience would be similar to Pennsylvania’s, he said it was therefore reasonable to assume that such a move would add an average of about $1.4 billion a year over 30 years to New Jersey’s future pension costs. That would jack up the total annual pension cost in the state budget from some $4.8 billion to about $6.2 billion a year -- a virtually impossible sum to cover, even with large tax increases, budget experts agree.

Christie administration officials declined to comment on the specifics or the implications of the Herzenberg study.

“Since the Governor's Budget Message last February, the administration has consistently called attention to the considerable long-term pension and health liabilities challenging the State's pension system, and the need for further reform,” Christopher J. Santarelli, Treasury’s deputy director of communications, said in an email.

“The Governor created and appointed a bipartisan panel of independent experts to the New Jersey Pension and Health Benefit Study Commission in August to provide recommendations to address the State's entitlement crisis. The commission released its first status report at the end of September detailing the scope of challenges facing the existing system. We expect the commission's final recommendations soon,” he said.

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